While 2015 may be remembered by some as the year that the Chinese growth story came across a reality check, it will more likely be regarded as the year that the bottom fell out of the resources market. Certainly, the credit crunch saw larger price drops across the entire index but, for investors in mining and oil stocks this year, blood has most certainly been running in the streets.
Clearly, all investors are aware that the financial performance of resources stocks is highly correlated to the price level of commodities. However, few investors believed that the oil price would slump to below $50 (and show little sign of making a sustained rally), gold would decline to a 5-year low and iron ore, the steel-making ingredient, would plummet to a 10-year low. As such, the share price falls of resources stocks have been huge, simply because the market is pricing in further falls in future.
For example, the share prices of oil stocks such as Premier Oil (LSE: PMO) and Xcite Energy (LSE: XEL) have collapsed by 49% and 21% respectively since the turn of the year. In addition, Mozambique-focused mining company, Kenmare Resources (LSE: KMR), has seen its share price drop by 21% year-to-date.
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Looking ahead, the performance of all three companies is clearly highly dependent upon the prices of commodities which, in turn, affects investor sentiment. However, Premier Oil appears to be relatively well-placed to post much improved share price growth, simply because it is so cheap and has a relatively appealing asset base. For example, it trades on a price to book (P/B) ratio of just 0.4 despite being forecast to post a pre-tax profit of almost £100m next year. This puts it on a forward price to earnings (P/E) ratio of just 7.6, which indicates that its shares have a sufficient margin of safety to merit purchase.
In addition, Premier Oil is better diversified than many of its resources peers. Certainly, its North Sea operations may be struggling, but the drilling programme at its joint venture operation in the Falkland Islands is progressing well and sizeable reserves have already been uncovered despite the programme not yet being complete. As such, with the potential for positive news flow as well as a dirt cheap share price, Premier Oil seems to be a very appealing buy at the present time.
Xcite Energy, meanwhile, also has a very strong asset base. Its 100% owned Bentley field in the North Sea would, with a higher oil price, be hugely appealing. However, the problem is that operating costs in the North Sea have historically been somewhat higher than in other parts of the globe, making margins tighter and, with a low oil price seemingly likely to remain over the medium term, this could cause investor sentiment in Xcite Energy to come under a degree of pressure. Certainly, it could prove to be a sound long term investment, but there appear to be more favourable options in the oil space at the present time.
As with Premier Oil, Kenmare Resources is expected to move from being a loss-making business to a profitable one in 2016. Certainly, its forecast pretax profit for next year is just £12m which, when you consider that Kenmare made a loss of £100m last year, is not particularly high on a relative basis. However, investor sentiment in the stock could pick up strongly in the months ahead – especially since Kenmare trades on a P/B ratio of just 0.2. And, while the company has a substantial debt pile, it was refinanced earlier this year. Therefore, while it is a relatively risky investment, Kenmare’s margin of safety appears to be sufficient for less risk averse investors to buy a slice of it.
